There are religious nonconformists. There are climate change deniers. And there is now a new class of political agnostic: the secular stagnation skeptic. According to a piece in Time magazine this week, Barry Eichengreen finds the issue of secular stagnation so divisive amongst academic economists that he has coined a new term to help us sort ourselves into believers and non believers: the
secular stagnation Rorschach Test. I like that term. And as I look at the ink blot of incoherent theory and misinterpreted facts that is presented to us for interpretation I find myself peering at a late Turner painting. I am straining to see the ship in the blizzard.
The Time piece is supposed to explain, to the layperson, what economists mean by secular stagnation. It serves only to spread the confusion that was laid by Larry Summer’s original article in which he resuscitated the term ‘secular stagnation’, originally coined by the American economist Alvin Hansen.
The confusion that originates in Larry’s article is between economic theories of unemployment and economic theories of growth. On unemployment, economists can at least agree to disagree.
For the thirty years leading up to the Great Recession, most economists built economic models where there is never any unemployment and the quantity of labor demanded is always equal to the quantity of labor supplied. Although there are still a few rosy tinted true believers who think that this makes sense; for the most part, the breed is dying out. It has been replaced by a new religion that genuflects to the altar of the sticky price. These ‘New Keynesian’ economists agree that, in the long-run, the quantity of labor demanded will equal the quantity of labor supplied. But, in the short-run, high unemployment persists because wages and prices are ‘sticky’.
Larry is not in either of these camps. Nor am I. I have spoken at length with him about this. Larry sees high involuntary unemployment as an equilibrium situation. I have modeled that idea in my own work where I use the theory of labor market search to explain why high involuntary unemployment may persist. And Larry has written papers with Olivier Blanchard where low involuntary employment may persist as workers become discouraged and remain out of the labor force. The exact formulation of this idea is unimportant. Larry and I are on the same page. Market economies are not self-stabilizing and they do not quickly adjust to find the socially optimal employment rate in the absence of active stabilization policies.
That brings me to the theory of economic growth. On this topic, despite more than twenty-five years of intense and active research, there is little or no consensus. The dominant way that macroeconomists model economic growth was developed by Robert Solow in the 1960s. Growth, in the Solow model, is caused by an exogenous increase in an unexplained factor called technological progress.
We produce goods by combining capital, land and labor using blueprints that represent the state of knowledge. If we had combined one acre of land with twenty-five machines and one hundred people in 2000 we might have produced (by way of an example) one hundred units of output. If we had combined one acre of land with twenty-five machines and one hundred people in 2001, we might have produced one hundred and three units of output. In this example, the economy grew by three percent between 2000 and 2001. But why did this happen?
According to the Solow model, the economy did not produce three percent more output in 2001 because we used more land, more labor, or more machines (although these may also have increased). It produced three percent more output because entrepreneurs used better blueprints. And according to the economic theory that is fed into almost all macroeconomic forecasting models, the reason for the improvement in those blueprints has nothing to do with economic policy and it has nothing to do with population growth, with investment spending or with changes in the unemployment rate. It is a black box we call technological progress.
There has, of course, been a great deal of work on theories of endogenous growth. Paul Romer and Robert Lucas have both produced seminal pieces on that topic that led to reams of economic research papers that try to understand Solow’s black box. To a macroeconomist who is interested in secular stagnation, these theories are a big disappointment.
I do not know why growth is low. There are a number of promising candidate theories. My own favorite explanation is that the Fed has lost control of inflation and that firms are not creating new technologies, at a pace that is fast enough to generate high growth, because uncertainty has increased. But I do not have a good economic model that links that idea in a coherent way with economic data. When it comes to economic growth; I have very little to say about why growth is currently slow. I am not unusual in that regard. Beware of economists bearing confident assertions about the best way to increase productivity growth. This is simply an area that we know very little about.
So what do I see in Turner’s painting? If secular stagnation means that unemployment can be permanently high if we don’t do something about it: I see secular stagnation. If secular stagnation means that we will be in trouble when the next recession hits because the Fed will not be able to lower interest rates further: I see secular stagnation. But if secular stagnation means that a massive bout of government investment in roads and infrastructure will cause firms to start producing better blueprints, I say; show me the theory and the evidence that leads you to believe that that is so.
Ignorance is not a reason for embarrassment. When medical doctors do not understand the cause of a disease, they cloak their ignorance with Latin. An illness of unknown origin is ‘idiopathic’. Economists should adopt the same strategy. When growth is slow and we don't know why, the economy is not experiencing secular stagnation. We are afflicted with a bout of idiopathic tardus augmenti.
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| Steam Boat off Harbour's Mouth: J.M. Turner |
The Time piece is supposed to explain, to the layperson, what economists mean by secular stagnation. It serves only to spread the confusion that was laid by Larry Summer’s original article in which he resuscitated the term ‘secular stagnation’, originally coined by the American economist Alvin Hansen.
The confusion that originates in Larry’s article is between economic theories of unemployment and economic theories of growth. On unemployment, economists can at least agree to disagree.
For the thirty years leading up to the Great Recession, most economists built economic models where there is never any unemployment and the quantity of labor demanded is always equal to the quantity of labor supplied. Although there are still a few rosy tinted true believers who think that this makes sense; for the most part, the breed is dying out. It has been replaced by a new religion that genuflects to the altar of the sticky price. These ‘New Keynesian’ economists agree that, in the long-run, the quantity of labor demanded will equal the quantity of labor supplied. But, in the short-run, high unemployment persists because wages and prices are ‘sticky’.
Larry is not in either of these camps. Nor am I. I have spoken at length with him about this. Larry sees high involuntary unemployment as an equilibrium situation. I have modeled that idea in my own work where I use the theory of labor market search to explain why high involuntary unemployment may persist. And Larry has written papers with Olivier Blanchard where low involuntary employment may persist as workers become discouraged and remain out of the labor force. The exact formulation of this idea is unimportant. Larry and I are on the same page. Market economies are not self-stabilizing and they do not quickly adjust to find the socially optimal employment rate in the absence of active stabilization policies.
That brings me to the theory of economic growth. On this topic, despite more than twenty-five years of intense and active research, there is little or no consensus. The dominant way that macroeconomists model economic growth was developed by Robert Solow in the 1960s. Growth, in the Solow model, is caused by an exogenous increase in an unexplained factor called technological progress.
We produce goods by combining capital, land and labor using blueprints that represent the state of knowledge. If we had combined one acre of land with twenty-five machines and one hundred people in 2000 we might have produced (by way of an example) one hundred units of output. If we had combined one acre of land with twenty-five machines and one hundred people in 2001, we might have produced one hundred and three units of output. In this example, the economy grew by three percent between 2000 and 2001. But why did this happen?
According to the Solow model, the economy did not produce three percent more output in 2001 because we used more land, more labor, or more machines (although these may also have increased). It produced three percent more output because entrepreneurs used better blueprints. And according to the economic theory that is fed into almost all macroeconomic forecasting models, the reason for the improvement in those blueprints has nothing to do with economic policy and it has nothing to do with population growth, with investment spending or with changes in the unemployment rate. It is a black box we call technological progress.
There has, of course, been a great deal of work on theories of endogenous growth. Paul Romer and Robert Lucas have both produced seminal pieces on that topic that led to reams of economic research papers that try to understand Solow’s black box. To a macroeconomist who is interested in secular stagnation, these theories are a big disappointment.
I do not know why growth is low. There are a number of promising candidate theories. My own favorite explanation is that the Fed has lost control of inflation and that firms are not creating new technologies, at a pace that is fast enough to generate high growth, because uncertainty has increased. But I do not have a good economic model that links that idea in a coherent way with economic data. When it comes to economic growth; I have very little to say about why growth is currently slow. I am not unusual in that regard. Beware of economists bearing confident assertions about the best way to increase productivity growth. This is simply an area that we know very little about.
So what do I see in Turner’s painting? If secular stagnation means that unemployment can be permanently high if we don’t do something about it: I see secular stagnation. If secular stagnation means that we will be in trouble when the next recession hits because the Fed will not be able to lower interest rates further: I see secular stagnation. But if secular stagnation means that a massive bout of government investment in roads and infrastructure will cause firms to start producing better blueprints, I say; show me the theory and the evidence that leads you to believe that that is so.
Ignorance is not a reason for embarrassment. When medical doctors do not understand the cause of a disease, they cloak their ignorance with Latin. An illness of unknown origin is ‘idiopathic’. Economists should adopt the same strategy. When growth is slow and we don't know why, the economy is not experiencing secular stagnation. We are afflicted with a bout of idiopathic tardus augmenti.